With interest rates remaining at the highest levels seen in over 20 years and inflation putting pressure on consumers, major banks are bracing for potential challenges related to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to address possible losses stemming from credit risks, including delinquent debts and lending, especially in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citi’s credit loss allowance rose to $21.8 billion, more than tripling its reserves from the previous quarter; while Wells Fargo recorded provisions of $1.24 billion.
This buildup in reserves indicates that banks are preparing for a potentially riskier lending environment, which could lead to greater losses from both secured and unsecured loans. A recent study by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of 2023, credit card balances surged to $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains under strain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of the COVID era, particularly regarding banking and consumer health. The stimulus deployed to consumers played a significant role.”
However, experts caution that issues for banks may emerge in the coming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect recent credit quality but rather banks’ expectations for future events. He remarked on the shift from a historical system where rising bad loans drove higher provisions to one where macroeconomic forecasts now guide these provisions.
Looking ahead, banks are anticipating slower economic growth, a rise in unemployment, and potential interest rate cuts in September and December, which could lead to an increase in delinquencies and defaults by year-end.
Citi CFO Mark Mason pointed out that the concerns seem concentrated among lower-income consumers, who have experienced significant declines in savings since the pandemic began. “While we still see an overall resilient U.S. consumer, we notice disparities in performance across income levels and credit scores,” Mason stated.
According to Mason, only consumers in the highest income bracket have more savings compared to early 2019, with those boasting a FICO score above 740 driving spending growth and maintaining strong payment rates. Conversely, individuals with lower FICO scores are facing increased borrowing and declining payment rates due to the pressures of rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, holding off on cuts until inflation approaches its goal of 2%.
Despite banks preparing for possible defaults later this year, Mulberry believes that current default rates do not indicate an impending consumer crisis. He is particularly focused on the distinction between homeowners and renters from the pandemic era. While interest rates have risen significantly, homeowners benefited from locking in low fixed-rate mortgages and are thus less affected by current economic pressures. In contrast, renters—who have faced a nationwide rent increase of over 30% from 2019 to 2023 and rising grocery prices of 25%—are feeling the financial strain more acutely.
Overall, the latest earnings reports suggest stability within the banking sector. Narron noted that there were no significant changes in asset quality this quarter, and indicators such as strong revenues, profits, and stable net interest income suggest a continuing healthy banking environment.
Mulberry concluded that there are positive elements within the sector, offering some reassurance about the financial system’s robustness. However, he added, “As long as interest rates remain high, we will continue to observe potential stress within the economy.”